Stocks fall to mark the end of a rough week. The S&P 500 fell 0.5% to 2,065 and the Dow Jones fell 0.3% to 17,773. The S&P 500 lost 1.3% for the week which was the worst weekly performance since February, however the index still is in the positive territory for the year and the month. Stocks pulled back slightly this week as optimism faded related to commodity prices, a weaker dollar, and China’s stimulus. Next week’s non-farm payrolls report which comes out Friday will provide more color and insight into the strength of the labor market and any potential decision from the Fed. The uncertainty regarding a possible Brexit and lingering concerns about China will lingering concerns for stock markets over the next few months. Yields in the US were mostly flat on the day. The two year yield fell 1 basis point to 0.78% and the ten year yield finished at 1.83%. The euro strengthened 0.8% against the US dollar to $1.145. The Japanese yen continued its strong appreciation after the BoJ’s inaction yesterday. The yen rose 1.5% against the dollar to Y106.51. Oil prices slid back slightly after rallying above $45 this week. WTI finished the week at $45.99 and Brent finished at $47.32.
After returning nearly 9% in the first quarter, long maturity Treasury bonds had a bad April. Long dated Treasuries fell 1.2% last month as investors priced in higher chance of inflation and growth. Higher inflation expectations means that investors demand more yield. Higher yields results in lower prices. High yield bonds returned nearly 4% in April which also marked a trend reversal from the first quarter. Investment grade credit returned 1.2%. Inflationary pressures and signs have ticked up in recent weeks. This includes rising gold prices, mining and energy shares outperforming, and higher market based inflation expectations. Higher oil prices have also contributed to higher inflation expectations, along with the weaker dollar. The relationship between the US dollar and inflation has global reach. As the US dollar weakens, this provides support to commodity prices. Higher commodity prices provide inflationary pressure in countries around the world for both producers and consumers of commodities. Investors are positioning themselves for the event of higher inflation. For two consecutive weeks asset managers have shifted out of long term Treasury bonds and into TIPS and gold. The ten year breakeven rate has risen to 1.71% now compared to 1.2% in February.
GDP for the Eurozone beat expectations, and the gross number surpassed the pre-financial crisis peak. The region’s economy grew 0.6% in the first quarter, as France’s GDP contributed strongly to growth. The EU therefore outpaced growth in the UK and the US, where GDP expanded at 0.4% and 0.5% in the first quarter respectively. This suggests that the ECB’s QE program is starting to have ramifications on the real economy. Expectations for GDP previously called for 0.4% growth. Domestic demand, stronger consumer spending, and an increase in investment were all beginning to show signs of life. However inflation still remains elusive. Inflation from the previous year fell to -0.2% from even in March. Core inflation also fell from 1% to 0.7%.
Since the Fed raised interest rates repo transactions have become less popular with investors. A repurchase agreement involves selling a security (usually a bond) to another party with agreement to buy it back at a slightly higher price. This provides the initial purchaser of the bond some yield. The Fed uses repos to guide a lower bound on interest rates. The Fed provides repos to banks and other financial institutions (repo from perspective from Fed, reverse repo from perspective of bank). Contrary to the Fed’s expectations, demand for the reverse repo facility has fallen to a two year low. Initially the Fed expected that higher repo rates would attract many banks to participate, but this has not been the case. Daily use of the program this month averaged $33.4bn compared to $141bn in September. This is because yields have risen in other areas of the short term lending market. Banks are able to earn higher rates of interest in investments such as commercial paper or CDs, so they have been using those instead.